Will The Risk Rally Endure?

September 6, 2019 — Mitul Kotecha

There has been a definitive turnaround in risk sentiment this week, with equities rallying and bonds falling.  Whether it can be sustained is another question. I think it will be short-lived.

Markets are pinning their hopes on trade talks which have been agreed be US and Chinese officials to take place in October.  These would be the first official talks since July and follow an intensification of tariffs over recent weeks.  However, talks previously broke up due to a lack of progress on various structural issues and there is no guarantee that anything would be different this time around.  Nonetheless, such hopes may be sufficient to keep market sentiment buoyed in the short term.

Data overnight was bullish for risk sentiment, with the US August ADP employment report revealing private sector gains of +195k, which was higher than expected.  The US ISM non-manufacturing index was also stronger than expected, rising to 56.4 in August from 53.7 previously.  This contrasted with the slide in the manufacturing PMI, which slipped in contraction below 50, reported earlier this week.  The data sets up for a positive outcome for the US August jobs report to be released later today, where the consensus (Bloomberg) is for a 160k increase in payrolls and for the unemployment rate to remain at 3.7%.

As risk appetite has improved the US dollar has come under pressure, falling from its recent highs.  Nonetheless, the dollar remains at over two year highs despite speculation that the US authorities are on the verge of embarking on intervention to weaken the currency.  While I think such intervention is still very unlikely given that it would do little to change the factors driving the dollar higher, chatter about potential intervention may still keep dollar bulls wary.  While intervention is a risk, I don’t think this stop the USD from moving even higher in the weeks ahead.

Conversely China’s currency, the renminbi has reversed some of its recent losses, but this looks like a temporary retracement rather than a change in trend.  China’s economy continues to weaken as reflected in a series of weaker data releases and a weaker currency is still an effective way to alleviate some of the pressure on Chinese exporters. As long as the pace of decline is not too rapid and does incite a sharp increase in capital outflows, I expect the renminbi to continue to weaken.

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A Host Of Global Risks

August 13, 2019 — Mitul Kotecha

Last week was a tumultuous one to say the least.  It’s been a long time since so many risk factors have come together at the same time.  The list is a long one and includes the escalation of the US-China trade war, which last week saw President Trump announce further tariffs on the remaining $300bn of Chinese exports to the US that do not already have tariffs levied on them, a break of USDCNY 7.00 and the US officially naming China as a currency manipulator.

The list of risk factors afflicting sentiment also includes intensifying Japan-Korea trade tensions, growing potential for a no-deal Brexit, demonstrations in Hong Kong, risks of a fresh election in Italy, growing fears of another Argentina default, ongoing tensions with Iran and escalating tensions between India and Pakistan over Kashmir.

All of this is taking place against the background of weakening global growth, with officials globally cutting their growth forecasts and sharply lower yields in G10 bond markets.  The latest country to miss its growth estimates is Singapore, a highly trade driven economy and bellwether of global trade, which today slashed its GDP forecasts.

Central banks are reacting by easing policy.  Last week, the New Zealand’s RBNZ, cut its policy rate by a bigger than expected 50 basis points, India cut its policy rate by a bigger than expected 35 basis points and Thailand surprisingly cutting by 25 basis points.  More rate cuts/policy easing is in the pipeline globally in the weeks and months ahead, with all eyes on the next moves by the Fed.  Moving into focus in this respect will be the Jackson Hole central bankers’ symposium on 22/23 August and Fed FOMC minutes on 21 August.

After the abrupt and sharp depreciation in China’s currency CNY, last week and break of USDCNY 7.00 there is evidence that China wants to control/slow the pace of depreciation to avoid a repeat, even as the overall path of the currency remains a weaker one. Firstly, CNY fixings have been generally stronger than expected over recent days and secondly, the spread between CNY and CNH has widened sharply, with the former stronger than the latter by a wider margin than usual.  Thirdly, comments from Chinese officials suggest that they are no keen on sharp pace of depreciation.

Markets will remain on tenterhooks given all the factors above and it finally seems that equity markets are succumbing to pressure, with stocks broadly lower over the last month, even as gains for the year remain relatively healthy.  The US dollar has remained a beneficiary of higher risk aversion though safe havens including Japanese yen and Swiss Franc are the main gainers in line with the move into safe assets globally.  Unfortunately there is little chance of any turnaround anytime soon given the potential for any one or more of the above risk factors to worsen.

Posted in Asia, Asian currencies, central banks, China, Currencies, Economics, emerging markets, equity markets, eurozone, Federal Reserve, FX, India, Interest rates, Japan, Politics, Singapore, Taiwan, Thailand, Trade, Trump, UK, US. Tags: , , , , , , , , , . Leave a Comment »

What To Watch This Week

July 22, 2019 — Mitul Kotecha

Market expectations for Fed FOMC interest rate cuts have gyrated back and forth following a recent speech by NY Fed President Williams, one of the key decision makers within the Fed FOMC. He appeared to support a 50bps rate cut at the meeting at the end of the month, but unusually this was clarified later.  If anything, as the clarification may suggest, the bigger probability is that the Fed eases policy by 25bps in an insurance cut.

There will be no Fed speakers in the days ahead but the Fed will assess developments this week in helping to determine the magnitude of easing. Attention will continue to centre on US earnings, with more than a quarter of S&P 500 companies reporting Q2 earnings this week.   On the data front, US Q2 GDP and July durable goods orders will command most attention.  The consensus looks for a slowing in GDP growth to 1.8% q/q in Q1 from 3.1% q/q in Q1 while durable goods orders are expected to increase by 0.7% m/m.

A major central bank in action this week is the European Central Bank on Thursday. While policy easing is unlikely at this meeting, the ECB is likely to set to set the market up for an easing in deposit rates at the September meeting.  ECB President Draghi could do this by strengthening his forward guidance, but as a lot of this is priced in by the market, a dovish sounding Draghi is unlikely to weigh too much on the EUR.

In the UK this week it’s all about politics. Boris Johnson is widely expected to be announced as the new Prime Minister.  GBPUSD has clung onto the 1.25 handle, as worries about a no deal Brexit continue to impact sentiment towards the currency.  Once Johnson is sworn in he and the government could face a no confidence motion, which could gain support should it be seen as an alternative to the UK crashing out of the EU.

National elections in Japan yesterday resulted in a victory according to Japanese press for Shinzo Abe’s coalition, its sixth straight victory, with the governing LDP winning over half the 124 seats. The results were no surprise, and unlikely to have a significant market impact, but notably Abe suffered a setback by not gaining a supermajority. He therefore cannot change the country’s pacifist constitution.

In emerging markets, both Russia and Turkey are likely to cut interest rates this week, with Russia predicted to cut its key rate by 25bp and Turkey to cut by at least 200bps if not more.  Elsewhere geopolitical tensions will remain a major focus for markets, as tensions between the UK and Iran intensify.

Posted in Asia, Asian currencies, Bank of Japan, Brexit, central banks, Currencies, ECB, Economics, emerging markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Interest rates, Japan, Monetary Policy, Turkey, UK, US. Tags: , , , , , , , , . Leave a Comment »

Dovish Fed Hits The US Dollar

June 20, 2019 — Mitul Kotecha

The US Federal Reserve shifted towards a dovish stance yesterday and asset markets applauded.   Against the background of signs of slowing growth, intensifying trade tensions and growing “uncertainties” about the economic outlook, the Fed removed the previous “patient” stance and instead noted that “act as appropriate to sustain the expansion”.   The bottom line is that the Fed is priming the market for easing as early as July, though the market had already primed itself by moving sharply in terms of pricing in rate cuts over recent weeks.   The market is now pricing in three rate cuts this year and at least one next year, which seems reasonable.

Clearly there are a huge number of uncertainties ahead, making the Fed’s job particularly difficult and the picture could look quite different should the upcoming G20 meeting in Japan (28-29 June) deliver some form of trade agreement between the US and China.  This would likely result in less need for Fed easing.  As I have noted previously there are still a huge number of challenges and obstacles to any such agreement, suggesting that market hopes of an agreement stand a good risk of being dashed.   Until then, risk assets will remain upbeat, with equity markets rallying in the wake of the Fed decision even as bond yields moved lower and gold prices reached a 5-year high.

The USD remains under pressure and took another blow in the wake of the FOMC meeting.  The USD has now lost ground against almost all G10 currencies except GBP amid Brexit concerns over the last month.  This has extended today and the currency looks set to remain under pressure in the short term as markets continue to price in Fed rate cuts.  The tension between President Trump and Fed Chairman Powell is not doing the USD any good either.  The USD index (DXY) is now threatening to break below its 200-day moving average (96.710) though this has proven to provide strong support in the past.  A sustained break below this level could see the USD extend losses against major and many emerging market currencies.

Posted in Brexit, central banks, China, Economics, Economy, Federal Reserve, FX, Interest rates, Monetary Policy, Trump, US, US administration. Tags: , , , , , , . Leave a Comment »

Are Recession Risks Rising?

June 4, 2019 — Mitul Kotecha

It is incredible that just a few months ago most analysts were expecting at least two if not three interest rate hikes by the Federal Reserve.  How quickly things change.  Markets are pricing in at least a couple of rate cuts by the FOMC while US Treasury yields have fallen sharply as growth concerns have intensified, even as the hard economic has not yet turned that bad.  Recession risks are once again being actively talked about as trade fears intensify, with President Trump threatening increased tariffs on both Mexico and China.  As I noted earlier this week, trade tensions have escalated.

Reflecting this, core bond markets have rallied sharply, with 10 year US Treasury yields dropping by around 60bps so far this year, while bund yields are negative out to 10 years.  Historically such a plunge would be associated with a sharp weakening in growth expectations and onset of recession.  However, equity markets are holding up better; the US S&P 500 has dropped around 6.8% from its highs but is still up close to 10% for the year.  Even Chinese equities are up close to 20% this year despite falling close to 13% from their highs.  Equities could be the last shoe to fall.

In currency markets the US dollar has come under pressure recently but is still stronger versus most currencies this year except notably Japanese and Canadian dollar among major currencies and the likes of Russian rouble and Thai baht among emerging market currencies.  On the other end of the spectrum Turkish lira and Argentine peso have fallen most, but their weakness has largely been idiosyncratic.  In a weaker growth environment, and one in which global trade is hit hard, it would be particularly negative for trade orientated EM economies and currencies.

The US dollar has a natural advantage compared to most major currencies at present in that it has a relatively higher yield. Anyone wishing to sell or go short would need to pay away this yield.  However, if the market is increasingly pricing in rate cuts, the USD looks like a much less attractive proposition and this is what appears to be happening now as investors offload long USD positions build up over past months.  Further USD weakness is likely at least in the short term, but it always hard to write the USDs resilience off.

Going forward much will of course depend on tariffs.  If President Trump implements tariffs on an additional $300 billion of Chinese exports to the US as he has threatened this would hurt global growth as would tariffs on Mexico.  Neither is guaranteed and could still be averted.  Even if these tariffs are implemented fears of recession still appear to be overdone.  Growth will certainly slow in the months ahead as indicated by forward looking indicators such manufacturing purchasing managers’ indices, but there is little in terms of data yet to suggest that recession is on the cards.

 

Posted in Asia, Canada, China, Currencies, Economics, Federal Reserve, FX, Trump, Turkey, US, US administration. Tags: , , , , , , . Leave a Comment »
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